Mediobanca Finds Worry in New Italy Yield Gap

ROME–The difference in sovereign borrowing costs between Italy and Germany is no longer the best indicator of “solvency risk,” Mediobanca analyst Antonio Guglielmi said in a note published Monday.

A superior indicator now is the yield gap between Italian Treasury bills, or short-term debt notes, and longer-term Italian government bonds whose residual duration is the same as those bills, he said.

This measure signals a higher premium than before the European Central Bank’s euro-salvaging Outright Monetary Transactions and indicates that Italy’s “solvency risk is surely here to stay,” Mr. Guglielmi said.

A review of the yield gap between short-term BOTs, or Buoni Ordinari del Tesoro, as Italy’s T-bills are known, and equivalent off-the-run bonds with the same three months to maturity was just 0.02 percentage point in the precrisis years, and peaked at 0.71 percentage point at the height of the crisis. Today it is down to 0.18 percentage point, Mr. Guglielmi said.

But that’s 54% of the average actual 0.34% yield on T-bills, compared with a 25% premium before the ECB’s OMT program was announced and only 10% in the early stage of the euro-zone crisis in 2010, the London-based analyst noted.

Given the debt securities being compared mature at the same time, the only reason for a difference is the risk of any debt reprofiling in the event of default, which would affect BTP bonds, or Buoni del Tesoro Poliennali, and not short-term BOTs, he said.

Sovereign defaults elsewhere have tended to focus on bonds and not bills, in large part because of the time it takes to agree to restructuring terms, during which time T-bills can be redeemed, and the need to provide short-term funding. Moreover, the new collective-action clauses required for new European government debt issuance doesn’t apply to money-market instruments, meaning bills maturing in 12 months or less.

If the difference wasn’t believed to matter, investors could seize an easy arbitrage opportunity in the current Italian market.

The new proxy for default risk reflects the success of ECB President Mario Draghi‘s OMT announcement, which drove down Italy’s spread, or interest-rate premium, over Germany by 1.84 percentage points since last August.

That development has been met with relief in Italy, where the “spread” had become a common fixture on general news programs–so much so that Prime Minister Mario Monti joked that his grandson had been nicknamed “Spread” by his preschool companions.

But Mr. Guglielmi says that the spread has “lost a good part of its relevance as an indicator of the market’s perception of the solvency risk of Italy” and that its compression “does not mean the market has substantially changed its stance.”

To be sure, the 0.18-percentage-point gap now evident for Italy pales in comparison with the average 0.65-percentage-point higher yield on Greek government bonds over Greek T-bills in 2011, Mr. Guglielmi said.

He made his observations as part of a preview of Italy’s election next weekend.